Good asset allocation is fundamental to continued solid performance.
By Dan Keller
Many people use a very simple, straightforward approach to their end of the year review: sell the losers, keep the winners. Like most things, what's best for your portfolio isn't always that easy. Consider the following aspects before making any changes.
First, don't just sell out of a loser position just because you're tired of looking at it. Revisit your reasons for owning it in the first place. Are they still valid? If so, then give it a little more time to fully develop.
How do your gains and losses stack up for the year? If you've got more than $3000 of short term losses (investments sold at a loss which were held less than one year,) you can't use any more in this tax year. You'll have to carry the excess loss forward into the next year to use it. But if your gains are enormous (there's no limit on the gains the IRS will tax) or even small, then hit the bid on the stock and generate a loss or lessen your taxable gains (short term losses can be taken against short term gains.) You are allowed to deduct up to $3000 in short term losses from your income, so if you're selling investments you've held less than one year (short term holdings,) keep your losses to a maximum of $3000, if possible.
But there's even more to consider because you never want to sell an investment for tax purposes alone. Your primary goal is to maximize your wealth through investing. Even if you have a short term loss in an investment that will help minimize your taxes if you sell it, don't sell it if it still looks like a good, long term investment. Of course, there will be many who suggest you can sell an investment then buy it back without any negative effects, but there are a few reasons that may not be the case.
First, to take the loss on an investment and then buy it back, you must wait at least 30 days or the Internal Revenue Service won't allow you to use the loss for tax purposes. Second, if your strategy is to buy it back, you've just generated two rounds of commissions: the first when you sell it, and the second when you buy it back. Third, your investment may take off before the 30 day wait is over, and then you have to decide to jump back in or wait. If you wait, it may be much higher when you buy it back. Do not sell investments and then think you can easily buy them back. They rarely cooperate with tax strategies.
Also, take a look at the asset classes you have in your portfolio. Good asset allocation is fundamental to continued solid performance. If you own too much large cap growth or international for example, reduce your positions in those and rebalance to your original strategy. Be sure to use bond positions and non-correlated asset classes to manage the overall risk in your portfolio. Avoid the highs and lows of the market by being well balanced.
Another problem many investors have, especially older ones, is being too conservative. Having most of your investments in money market funds and/or conservative bond funds to preserve capital can leave you vulnerable to inflation. In fact, if inflation were to return in any meaningful way (it always has historically), these investments would erode your buying power because their rate of interest isn't going to keep up with the rate of inflation. Stocks are a necessary ingredient in preserving capital. Your allocation in stocks depends on your level of risk tolerance, and for those investors with the lowest tolerance for risk, look into good growth and income mutual funds where there's a balance between capital appreciation and current income. Avoiding stocks altogether is not prudent management of your hard earned capital. Even if you allocate only 10% of the portfolio to stocks, your performance may be improved over the long run.
The end of the year is a time for investors to take a focused look at their portfolios. You certainly should. But don't make any moves before you think through the consequences and how they'll affect your long term goals. As an investor, you'll want to keep a balanced portfolio with a long term goal in mind. Don't get caught up in trying to trade in and out of popular stocks, industries, or mutual funds. That's not how you make money. Careful planning, proper asset allocation, and patience are the best ways to reach your financial goals. Contact your ALCOS representative to help you make sure your portfolio works for you.
Contact Dan Keller at: 586.446.3516